(Bloomberg) -- Jeremy Hunt faces a difficult balancing act in his annual budget next week, under pressure to deliver eye-catching tax cuts to give a pre-election boost to his ailing Conservative Party, yet also hamstrung by the fragility of the UK public finances.

The Chancellor of the Exchequer is due to announce personal tax cuts on March 6 amounting to at least 1 percentage point off either the basic rate of income tax or national insurance, according to people familiar with the matter who requested anonymity because the budget hasn’t been finalized. Hunt and Prime Minister Rishi Sunak want to go further than that, but ultimate decisions will be made this weekend after considering final economic estimates from the Office for Budget Responsibility, the people said.

Hunt’s challenge has been finding the money for voter-pleasing giveaways given a weak economic starting point: prior to any new policies, the OBR has said he has about £13 billion ($16.4 billion) of breathing space before he breaches his own fiscal rule to have the national debt falling in five years’ time. That margin is near historic lows — and he will want to retain some of it. That’s why he’s been considering revenue-raising options including scrapping the non-domiciled tax status and extending a windfall tax on oil and gas company profits — to give himself more funds to play with.

“The room for maneuver is tiny which is never what you want as a chancellor, and definitely not in an election year,” said Helen Thomas, an ex-adviser to former Tory finance minister George Osborne and CEO of BlondeMoney, a macroeconomic consultancy. “He’s really got a problem.”

Hunt’s dilemma is magnified by the perilous position the Tories find themselves in the opinion polls. They’ve trailed the opposition Labour Party by around 20 points for months, and Sunak must hold an election by the end of January. The budget is potentially the last big set-piece opportunity for the Conservatives to change that narrative — though they could yet hold their annual conference in October and hold an Autumn Statement before a vote later in the fall or in the winter.

The Tories have suffered a string of recent heavy by-election defeats and are yet to recover from the economic chaos wrought by the premiership of Liz Truss and the scandal-hit leadership of ex-premier Boris Johnson. 

The grim electoral outlook is why Conservative MPs are calling for crowd-pleasing tax cuts that they can sell on the doorstep — and Hunt would like to find the cash for a 2 percentage-point cut to income tax or national insurance in order to answer those demands, the people said.

But against those demands Hunt has to balance the risk of going too far with any fiscal loosening, which may pressure Bank of England rate-setters to delay cutting interest rates if Hunt’s giveaways are deemed likely to fuel inflation. There’s also the latent fear of roiling the markets as Truss did with an enormous package of unfunded tax cuts.

“Jeremy Hunt has limited headroom against his fiscal target and with an election on the horizon, he will want to avoid giving investors any reason to re-assess the timing of interest rate cuts this year.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for their BUDGET PREVIEW

UK inflation is currently forecast to drop below the BOE’s 2% target in the spring, and Governor Andrew Bailey has said the Bank doesn’t need to wait for inflation to return to target before cutting interest rates from 5.25%. Speaking to lawmakers last month, he said the timing of cuts will depend on progress in tackling price growth.

“Hunt’s going to have to be careful,” said Vicky Pryce, chief economic adviser at the Centre for Economics and Business Research. “He’s relying hugely politically on the Bank of England bringing rates down for the feel-good factor to improve.”

Facing tight public finances Hunt has been examining tax-cutting options including a potential squeeze on future public spending. Yet he was already criticized in November for having spending assumptions that were deemed implausibly low and vague, with OBR chair Richard Hughes saying they were worse than fictional. Reducing future spending would also open Hunt up to the charge that he’s bringing back austerity at a time when public services are struggling.

Hunt told MPs last month the budget will continue the tax-cutting moves in the Autumn Statement, when he announced a 2 percentage-point cut in national insurance and gave a major tax break to businesses. He said he wants to pursue “smart” tax cuts that boost growth — a concern for the government after the country dipped into recession in the second-half of last year.

One area Hunt has been considering is the £50,000 salary threshold at which child benefit begins to be withdrawn from parents. It’s remained fixed since 2013 and means parents face an effective tax rate of up to 68% on income earned between £50,000 and £60,000. Campaigners such as finance expert Martin Lewis say the threshold is unfair, and lifting it is on a list of measures Hunt would like to do if the OBR’s final forecasts allow, a person said.

Other measures Hunt is expected to announce include a fuel duty freeze and extending the 5-pence-per-liter fuel duty cut that is otherwise due to expire later this month. He’s also considering reforms affecting the City, including a potential British ISA to spur investment in the domestic equity market. On Saturday, the Treasury confirmed Hunt will announce pension reforms first reported by Bloomberg that include requiring funds to disclose how much they invest in UK businesses.

However Hunt is set to disappoint Britain’s business community, rejecting requests including for him to raise the threshold at which firms pay value-added tax, bring back tax-free shopping for international visitors, and extend the full-expensing tax break to cover rented and leased assets. With such limited room for maneuver and with an eye on the election and ordinary voters, Hunt is unlikely to do any of those, a person said.

--With assistance from Philip Aldrick, Alex Wickham and Andrew Atkinson.

©2024 Bloomberg L.P.